Tuesday, December 06, 2011

Canada’s five biggest banks have reaped the benefits of a vast, stable retail network by reporting sizeable advances in – and, in some cases, record – earnings in their latest fiscal year.

Bank of Montreal, the last of the five to publish results, reported net income on Tuesday of C$3.27bn ($3.23bn) for the year to October 31, up 16 per cent from 2010.

In a remark that would apply to few of BMO’s US or European rivals, Bill Downe, chief executive, described 2011 as “a terrific year”, including record earnings from personal and commercial banking.

The Canadian banks have a low direct exposure to the eurozone. Europe makes up 6 per cent of total lending assets at Royal Bank of Canada, the most exposed. RBC officials note that much of its lending is to blue-chip European companies.

Even so, Mr Downe told the Financial Times that the eurozone crisis “has implications for overall economic growth, and in that sense it’s important”. The banks – like the Canadian economy – are also heavily dependent on the health of US financial markets.

All five banks – RBC, TD, Bank of Nova Scotia, BMO and Canadian Imperial Bank of Commerce – reported double-digit increases in fourth-quarter earnings. Returns on equity ranged from 14.3 per cent at TD and BMO to CIBC’s 20.6 per cent.

TD and Scotiabank reported record annual earnings of C$5.89bn and C$5.27bn respectively. Peter Routledge, analyst at National Bank Financial, expects TD to announce its third dividend increase in a year next quarter. The bank is one of a handful worldwide that still carries a Moody’s triple A credit rating.

“We’ve benefited from a very strong economy and good employment growth at home”, Mr Downe said. “We’re headquartered in a very stable country.”

He added that “the fact that we’re well-capitalised and have a strong balance sheet has drawn deposits to the bank”. BMO’s Chicago-based subsidiary, BMO Harris Bank, boosted its deposit market share to 11.6 per cent from 9.5 per cent, overtaking Bank of America as the region’s second-biggest deposit-taker.

RBC has sought to woo European wealth-management customers with an advert that features a leafy maple tree against a desolate, wintry backdrop. The caption reads: “Standing tall for our clients in an uncertain world.”

George Lewis, head of RBC’s wealth management division, said that “given the current environment, we chose to initially focus our campaign in Europe, where we believe the stability of RBC represents great appeal for clients”.

One analyst expressed concern about rising non-interest expenses as a common thread among the results. Fourth-quarter expenses at Scotiabank, normally among the most parsimonious, jumped by 15.4 per cent.

• We are increasing our 2012E and 2013E EPS by $0.10 each to $4.80 and $5.20 based on the resilient retail NIM and IFRS. We are increasing our one-year share price target to $63 from $57. Reiterate 1-SO based on above industry group profitability and capital, and substantial earnings leverage to some type of normalization in capital markets.

Last Friday before the open, the bank reported Core Cash (f.d.) EPS of $1.08 versus TD Securities at $1.09 and consensus of $1.08.

Impact

Slightly positive. With some helpers, Scotia delivered a basically in line result. The results were fairly balanced across the segments; importantly, we note continued progress in the International segment consistent with our expectations for above-average medium-term growth. We trimmed our estimates nominally, around lower near-term NIMs, but strong volumes, acquisitions and what we expect to be some increased expense discipline should help deliver reasonably good bottom-line growth in 2012. Overall, we continue to view Scotiabank as one of the best fundamental stories in the group. At current levels, we believe valuations are reasonably attractive and we reiterate our Buy rating.

Details

Sounds like some increased focus on harvesting recent growth/investment in 2012. We have agreed with Scotia’s decision to continue to press strategic investments/capital deployment over the past 24 months with an eye to building out the platform for medium-term growth. Efforts should continue in 2012, but management is suggesting a slight shift to harvesting returns over the coming year with some diminution in project spending and build-out which should manifest itself in better operating leverage and some better bottom-line earnings.

• Canadian P&C (TDCT) had strong earnings up 17% YOY to $905M, with U.S. P&C up 16% YOY to $328M. Wealth Management earnings were also strong increasing 28% YOY. Wholesale Banking earnings rebounded to $288M ($151 million before security gains) from $108M in Q3/11. Trading revenue was $286M versus a dreadful $109M in Q3/11. Trading revenue in the quarter was driven by very strong FX and equities with interest rate and credit recovering modestly.

• CM reported operating EPS of $1.87 (excl. a $0.12 merchant banking gain and other charges of $0.08). Earnings were strong, in line with our expectations of $1.90, however, handily above consensus EPS of $1.81.

• Operating ROE: 20.4%, RRWA: 2.71%, CET1: 8.1%

Implications

• Earnings were driven by strong results from Retail & Business Banking and Wealth Management up 15% and 20% y/y, respectively. Wholesale Banking earnings were resilient at $156M versus $160M in the previous quarter and a very weak $67M a year earlier. Trading revenue was solid at $165M versus $146M in Q3/11 and $157M a year earlier.

• CM has positive earnings momentum in 2012 from expected 1.8% reduction in statutory tax rate, $0.15 earnings accretion from American Century and $0.09 per share run rate accretion from preferred share redemptions and $0.20 accounting pickup from IFRS.

Recommendation

• We are increasing our 2012E and 2013E EPS both by $0.20 to $8.10 and $8.80, respectively due to IFRS and expected stronger operating results. We reiterate 1-SO due to CM's high relative profitability, low relative valuation and low risk balance sheet and business mix.